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THE MANY BENEFITS OF I SAVINGS BONDS

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       Investor's Insight - Wednesday, January 25, 2006           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"

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Comment The Post Below...


THE MANY BENEFITS OF I SAVINGS BONDS
by Scott Burns

Reader mail tells me that I Savings Bonds are one of the 
most misunderstood good deals available to the investing 
public. They offer a competitive return, can be held for 
up to 30 years, and can be redeemed in relatively small 
amounts at no cost. While they are being held, the inte-
rest they earn is accumulated tax-deferred.

Unlike mutual funds that invest in bonds, the value of 
I Savings Bonds does not fluctuate. It only goes up.

Unlike most tax-deferred annuities, the penalties for 
early redemption are not severe.

Unlike brokered CDs, the value of the investment does not 
fluctuate with interest rates.

So let's start at the beginning and go through the basic 
questions:

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What are I Savings Bonds? Unlike EE Savings Bonds, which 
earn and accumulate tax-deferred interest at a rate pegged 
to the rate on five-year Treasury obligations, I Savings 
Bonds offer an inflation-protected rate of return based on 
the Consumer Price Index and a premium over the inflation 
rate. Like EE Savings Bonds, the interest earned is accum-
ulated tax-deferred.

How is the yield on I Savings Bonds determined? Every six 
months the basic interest rate may change. The basic inte-
rest rate is a premium that is added to the rate of infla-
tion. Bonds purchased in the current period (November to 
April), are earning at a 6.73 percent annualized interest 
rate based on a 1 percent premium and a 5.70 percent in-
flation rate.

Bonds purchased in other periods will be earning at diffe-
rent rates because there were different basic interest 
rates in other periods. These rates varied from a high of  
3.60 percent for bonds purchased in the May to October 
2000 period to a low of 1 percent for bonds purchased in 
the November 2005 to April 2006 period. Since the rate of 
inflation is added to each basic interest rate, ALL the I 
Savings Bonds issued in earlier periods are currently 
earning more than 6.73 percent. Bonds purchased in the May 
to October 2000 period, for instance, are currently earn-
ing a whopping 9.40 percent.

Why is the basic interest rate so much lower today than it 
was when the bonds were introduced? Think of it as market-
ing. The bonds were new and unfamiliar when they were in-
troduced in 1998. Today, people understand that the basic 
rate is a premium over the inflation rate. The 1 percent 
basic rate bonds available today are yielding 6.73 percent, 
well over yields on bank CDs, tradable Treasury securities, 
and mutual funds that invest in government securities.

Will the current yield decline? It all depends on the in-
flation rate. If inflation declines, the composite interest 
rate (basic rate plus inflation rate) will decline. The 
real return over the rate of inflation, however, will be 
fixed at whatever the basic interest rate is when you buy 
the bonds. If you are concerned about future inflation, 
these bonds are likely to give you more protection than 
conventional bonds.

Is a 1 percent premium over inflation a good rate? Accord-
ing to Ibbotson Associates, intermediate and long-term 
government bonds earned a premium of 2.4 percent a year 
over the annual inflation rate between 1926 and 2004. U.S. 
Treasury bills earned a premium over inflation of only 0.7 
percent over the same period.

Investors, however, could experience long periods when in-
flation exceeded what they were earning on their convent-
ional bonds. I Savings Bonds will always earn a premium 
over inflation. In addition, the interest is tax-deferred. 
As a consequence, I believe they are superior to Treasury 
bills and competitive with conventional bonds. They are 
particularly superior to most mutual funds and variable 
annuities that invest in government bonds because mutual 
fund and variable annuity expenses reduce their advantage. 
The average intermediate-term government bond fund, for 
instance, has an expense ratio of 1.09 percent. This would 
reduce the 2.4 percent premium over inflation to 1.31 per-
cent -- and the yield isn't tax-deferred. The average in-
termediate bond sub-account in a variable annuity has a 
total expense burden of 1.90 percent, reducing the 2.4 per-
cent historic premium over inflation to 0.5 percent.

When you do the math against competing vehicles, I Savings 
Bonds look very attractive.

Do I Savings Bonds have any other advantages?  They are 
particularly useful for retirement planning and taxes. 
Since they can be redeemed at their accumulated value at 
any time after five years without penalty, they offer risk-
free access to sums of money in very flexible amounts.

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In addition, your tax liability will be on only the accu-
mulated interest portion of the redeemed amount. A $100 I 
Savings Bond purchased in November 2000, for instance, 
will be redeemable for $139.88 this April. A retiree can 
access the full amount but will need to pay income taxes 
on only $39.88 in interest.

In comparison, mutual fund returns are currently taxable. 
Variable annuity withdrawals are 100 percent taxable in-
come until the accumulated income is exhausted.

Where can I buy I Savings Bonds? The surest way is to use 
the Web. Enter your ZIP code in a site listed below, and 
it will give you the phone number of the nearest Federal 
Reserve Bank. You can also set up an account online. It 
is also possible to buy them through a regular bank, but 
many readers who have tried say they are not available 
through that channel.

ON THE WEB

Enter your ZIP code and find the Federal Reserve Bank for 
help and transactions: www.publicdebt.treas.gov/sav/savfrb

Composite earnings rates for I Savings Bonds with diffe-
rent issue dates: www.publicdebt.treas.gov/sav/sber0506

Rate on I Savings Bonds purchased in this period: 
www.publicdebt.treas.gov/com/comi1105

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).

COPYRIGHT 2005 UNIVERSAL PRESS SYNDICATE

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